Does Fed Action Really Affect The Price Of Gold And Silver?

by: Avi Gilburt

I know that everyone that opens this page is already coming in with the notion that "the answer is so obvious, you would have to be a fool to think otherwise." However, maybe I am foolish, but I do not think the answer is as clear as most believe.

The common understanding is that when the Fed hints at injecting more "money" into the system, the market moves on those words. But, if we really think about it, is that really telling us that the Fed's actions are actually moving the metals, or is it the common perception of what those actions could do which is actually moving the metals?

I know that some of you are now thinking that I am playing a game in semantics with this question, but I can assure you that it is not a game and it is something you want to strongly consider because what I am truly referring to is underlying sentiment.

I have brought this issue up many times before, so I want to just bring up a few points I have made in prior articles.

First, during his tenure, and in several hearings in front of the Joint Economic Committee, Mr. Alan Greenspan, former Chairman of the Federal Reserve, noted that the idea that the Fed can prevent recessions is a "puzzling notion." Rather, he went on to say that the stock market is driven by human psychology and waves of optimism and pessimism.

Mr. Greenspan has also been quoted as saying:

The cause of economic despair, however, is human nature's propensity to sway from fear to euphoria and back, a condition that no economic paradigm has proved capable of suppressing without severe hardship. Regulation, the alleged effective solution to today's crisis, has never been able to eliminate history's crises.

Alan Greenspan, Financial Times, 2008

Second, if it were true that the government can affect the prices in the markets all the time, then why did the markets enter into one of the most dramatic declines in its history in 2008 right after several government agencies announced initiatives to bolster the markets with stimulative contrivances such as TARP, TALF, QE, etc?

Well, some may say that it did save the markets much later, or that it did not initially really take hold. In truth, if we were to look at it from an intellectually honest perspective, if a specific action seems to cause a specific reaction many times but not all the time, does it mean that the specific action is truly the direct catalyst for the reaction? Rather, if one were to really look at this from a scientific perspective, one would have to start looking for what actually leads to the reaction all the time or else it is not a solid hypothesis.

As I have stated before, could it really be the sentiment of investors which is moving the market, and not actually the Fed? If the larger sentiment is negative and declining, then any announcement by a government agency will not be able to stem the tide of such sentiment until such sentiment has run its natural course. This is exactly what we saw in 2008, as well as in the Great Depression, which are two of history's most dramatic examples. During the Great Depression, one of the most negative sentiment periods of the last 100 years, Irving Fisher noted:

The Federal Reserve System, from February to December 1931, increased the issue of Federal Reserve notes by 80%. These issues were due to bank failures which made necessary a larger use of cash. Yet, after a wave of bank failures . . . both banks and their depositors began raiding each other in a cut-throat competition which more than defeated the new issues of Federal Reserve notes.

Irving Fisher, Booms and Depressions, 1932


I proffer that, rather than reading tea leaves about what the Fed is going to say or not going to say, would it not be more productive to understand where the prevailing sentiment of investors stand at the time? Does history not teach us that this is really the dominant factor?

Therefore, this leads to the ultimate conclusion that government and government agencies can attempt to affect the prevailing sentiment. However, when the sentiment trend is opposite of the direction that the government wants us to move, there is nothing that anyone can say or do which will derail that train.

Disclosure: I am long SLV, GLD.